‘Financial strain’: Interest rate angst most severe for homebuyers in Ontario and B.C.

Potential interest rate hikes are stirring the greatest concern among homebuyers in Ontario and British Columbia – reflecting the wide disparity in housing affordability across the country.

A new report to be released Wednesday by BMO Financial Group found that some 53 per cent of home buyers in Ontario and 51 per cent in British Columbia will conduct personal “stress tests” to determine whether they can pay their mortgages in the event of a rate hike. That compares to a maximum average of 40 per cent across all other regions.

“What this shows is there really are two markets in Canada and the impact of rising interest rates will have different effects on buyers depending where they live,” said Sal Guatieri, senior economist at BMO Capital Markets. “Across the country, people aren’t too concerned about their ability to buy a house and manage their mortgages. But in Ontario and B.C., a much larger proportion of people are worried about interest rates going up and locking them out of the housing market, or when it comes time to refinance, increasing their financial strain.”

Following nearly a decade of low interest rates, the Bank of Canada began increasing its central rate last July, eventually pushing it to 1.25 per cent from 0.5 per cent. Last month, it opted to hold the rate steady. However, amid an increase in government bond yields, Canada’s biggest banks began raising posted mortgage rates last week. The Toronto Dominion Bank boosted its five-year fixed rate 45 basis points to 5.59 percent. The Royal Bank of Canada and the Canadian Imperial Bank of Commerce soon followed with their own hikes.

But that doesn’t mean all new mortgages will automatically be set at those higher levels, said Will Dunning, a Toronto-based economist specializing in the housing market. Though the posted rates may have changed, most home loans are based on the bank’s “special offer rate” which is generally lower.

“The interest rate in the market is what really matters in terms of what people can afford and that hasn’t changed much,” Dunning said. “Most people won’t see a major change, at least not immediately.”

By the time their mortgages reset, borrowers may also have higher incomes and more equity in their homes to help soften the effect of rising rates, said Benjamin Reitzes, a Canadian rates and macro strategist at BMO Capital Markets.

“Rising rates put pressure on the economy, they put pressure on spending but as long as the jobless rate doesn’t go up and as long as we don’t experience some other external shock, I don’t think there’s reason to panic,” he said.

Nevertheless, the ability of Canadians to manage the burden of their debt amid rising interest rates has been repeatedly identified as a key concern for the Bank of Canada.

About 47 per cent of outstanding mortgages will need to be refinanced this year, according to the Bank’s fall Financial System Review. And Toronto homeowners carry some of the largest debt burdens in the country, with 26 per cent of mortgages originated between 2014 and 2016 carrying loan to value ratios of 80 per cent. Just eight per cent of mortgages in Montreal and 7 per cent in Vancouver originated over those years carried the same ratios.

And in a separate report yesterday, the Canada Mortgage and Housing Corporation said that while the overall number of mortgages for which payments had not been made by the due date had declined in the third quarter of 2017, the share of mortgages considered bad debts due to non-payment for more than five months rose to 15 per cent — the highest level since 2014.

BMO has forecast two additional quarter-point rate interest rate hikes this year. Just how stressful those increases will be for Canadians depends largely on the pricing environment where they live, Guatieri said.

A typical family in Ottawa, for instance, would require about 16 per cent of its gross median income to service a mortgage on an average priced home – a ratio that has changed little in the last ten years. If interest rates were to rise by 2 per cent, the burden of carrying that same mortgage would rise to 20 per cent of a typical household income, he added.

“That’s very affordable, even if you add in a few more per cent for other housing related costs,” Guatieri said.

Compare that to Toronto, where home prices are considerably higher and where a typical family still needs 49 per cent of its income to qualify for a mortgage on an average property. With an interest rate hike of 2 per cent, that family would need 60 per cent of its income to carry the increased debt load.

“That effectively means people have to find an extra 20 per cent of income to qualify for a mortgage,” Guatieri said. “Again just a modest increase in interest rates in Toronto and Vancouver is a concern for most buyers.”

House prices in the Greater Toronto Area rose by more than 30 per cent last spring prior to the introduction of market cooling measures by the Ontario government. Though the price increases have been attributed largely to an extended period of low interest rates, a report released this week by the Building Industry and Land Development Association (BILD), found that government fees, taxes and charges added $186,000 to the price of an average new single family home and $121,000 to the cost of an average high-rise apartment in the GTA.

“Some of these costs, such as development charges, are increasing far faster than the rate of inflation, squeezing prospective new home buyers out of the market,” said Dave Wilkes, chief executive of BILD.